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For example Apple, Amazon, Microsoft all fulfilled these checkmarks when they were small companies. People who had invested in them during the phase where they were no longer obscure, (but still smallish companies) would still have made anywhere from 200-1000+% returns off of their initial investments.

I believe Tesla is also in that same stage. No longer obscure, but they're still a pretty small company that's not listed in the S&P 500. So far they have achieved one of their primary business goals, which is to double in size every 18 months.

  • They went from one small factory - to one small one and one Gigafactory in Nevada…
  • They added a second Gigafactory in China - doubling to two Gigafactories in 18 months.
  • They’re building one more in Germany and another in the USA - so they’ll soon go from two Gigafactories to FOUR.
  • Each Gigafactory can be doubled or even tripled in size…they’re designed to make that possible…
  • https://qr.ae/pNvQpb

What would be a reason not to invest in Tesla, or any similar small sized companies that have these same attributes?

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    Seriously, I would not call Tesla a SMALL SIZED company by any means. – TomTom Apr 6 at 14:17
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    Just to add to what @TomTom said... Tesla currently has 45,000 employees and a market cap of $40 billion! Depending on the industry the cut-off for "small business" is either 250 or 1500 employees. Telsa is 30x the larger number. – Michael Apr 6 at 19:03
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    Have you researched how many such companies didn't produce those kinds of returns? Are you sure they don't outnumber the ones that did? – Daniel Apr 6 at 23:06
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    Someone should edit the question title because it's so radically out of synch with the Tesla pump text. – Daniel R. Collins Apr 7 at 13:30
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    Tesla's market capitalization is three times the size of General Motors. Can you explain why you consider it to be a small cap company in the face of the overwhelming evidence that it is enormous? – Eric Lippert Apr 7 at 21:59

12 Answers 12

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What would be a reason not to invest in Tesla, or any similar small sized companies that have these same attributes?

A big, big, big reason not to invest in such a company is that its stock may be overvalued already.

I think a lot of people have the misconception that a stock's price reflects the company's net assets, and so if a company doubles in size, its stock price will double, too.

That's not true at all. A stock's price reflects what investors think the stock is worth. This means that if, say, investors are expecting a company to double in size, and it does double in size, then on average, the stock price will go up by 0%. It'll just stay flat. If investors are expecting it to triple in size and it merely doubles in size, the stock price should go down by 33%.

So, if you're trying to beat the market by picking stocks, you absolutely have to look at the stock price and compare that to how much the stock is actually worth.

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    I have un-fond memories of trying to explain this to a friend who was griping about his AAPL going down after their best quarter ever. – Jared Smith Apr 7 at 10:26
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    @BЈовић Suppose a company currently earns a profit of 300 quatloos per year. I estimate that next year it will earn 600 quatloos instead - that means I am willing to pay more today for stocks than someone who thinks it will only earn 400 quatloos. If it does only earn 400 quatloos, then I might sell my shares to the other person for less than I bought it for, because I just want to get rid of the stock, lowering it. If it earns 600 quatloos, but people think that the year after it will still only earn 600 quatloos, then they will buy for the same price that I did, so it stays the same. – Chronocidal Apr 7 at 13:16
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    @BЈовић What this answer is saying is that the stock price does go up, but it happens in advance on the expectation of the company doubling in size, rather than at the moment the size increases. – JBentley Apr 7 at 14:06
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    @Ian I'm not sure why you are focused on dividends? Assuming an efficient market, there is effectively no difference between paying a dividend and reinvesting that money in the company. With the former, the price will drop by the amount of the dividend, in the latter, the price will (again, assuming it is efficiently priced) remain the same. In both cases you have the same amount of value afterwards. – Kris Harper Apr 8 at 16:03
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    "Owning a share has no inherent value" that's just not true. It's a share in a company that has assets and generates earnings. The value is exactly what someone else is willing to pay for it. The same argument can be made for any asset that doesn't produce cashflows. Gold, for example, or a plot of land. – Kris Harper Apr 8 at 16:53
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Be careful about survivorship bias. For every Apple, Amazon or Microsoft which grew from a garage company to an international megacorporation there are thousands of cases of companies which stayed small or went bankrupt.

How can you from the outside judge how great the leadership, how talented the workers and how amazing the product of a company really is? Public perception is one thing, but you often don't know what really goes on within a company. The hipster CEO might actually be an angry despote who doesn't know what he is doing, the talented engineers might be interviewing at other companies and the product might have no chance against an unpublished product from a competing company with far more resources.

Regarding Tesla: They enjoyed the prestige of being the first company to mass-produce electric cars which looked and felt like real cars. But they are no longer alone on that market. More and more well-established car companies want a piece of that cake and brought their own electric cars to market. Will Tesla be able to maintain their market leadership? Will they get relegated to one among many? Or perhaps will they even get crushed by the competition? Only the future will tell.

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    It's easy to look at a company like Apple and think they were obviously a great company, but that only comes with the benefit of hindsight. In its short history, Apple has also flirted with completely folding and at one time kicked out its own founder for being so toxic. They got where they are today through a long series of unconventional decisions and products that turned out successful, but could have just as easily sunk the company. Investing with them was always a gamble. – Seth R Apr 6 at 15:47
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    This is a key thing to note. Yes, Apple checked those boxes, but so did Acorn, Kaypro, Sinclair, and dozens of other early-80s computer companies you've probably never heard of. – Mark Apr 7 at 1:49
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    "the product might have no chance against an unpublished product" - There are other ways the product can be less amazing than it seems. The general public may just not want it much even if you personally think it's the most amazing thing ever. The public may claim to want it, but when reality and/or the price-tag sets in, they change their mind. The product may turn out to be less amazing than advertised because the initial idea just wasn't that viable. It may also just not be the right time, in terms of both luck and availability of competing products or products this depends on. – NotThatGuy Apr 7 at 9:16
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    @NotThatGuy, ...heh. I was part of a startup that built an early electronic medical records system. Our founder was an ER doc who basically designed the product in his own head. Every physician we showed it to loved it -- not only did they buy the product, but a lot of them invested in the company. But when when it came to install it on a customer site... our ER-doc founder/designer never really thought or cared about what the office staff workflow was like, or about integration with existing scheduling tools, or anything else that would make it usable for non-docs. We had lots of returns. – Charles Duffy Apr 7 at 15:30
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    I was expecting this link for survivorship bias – Pac0 Apr 8 at 9:47
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In the case of Tesla, two reasons. 1) Its stock price has already been driven to unrealistic levels by fans; and 2) The corporate leadership.

Point #1 seems fairly obvious. #2 requires some comment. The problem here is that Elon Musk seems to have a compulsion to balance every great idea with a really stupid one. Make good electric cars? Great idea! Mess them up by trying to make them self-driving, thus increasing the cost, exposing the company to massive liability lawsuits, and ensuring that a segment of potential buyers wouldn't take one if it was free? Not so great :-(

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    To put point number 1 into perspective: the prices on Tesla stocks are currently so insanely high that Tesla's market cap is that of General Motors and Volkswagen combined. There is no rational explanation for such a valuation, even if EVs will become a larger part of the automobile market. – amon Apr 6 at 7:14
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    That pretty much sums it up. Even if Tesla replaces 2 BIG car companies, the current valuation likely makes that a loss. It is amazing, but it is not worth that much. – TomTom Apr 6 at 14:16
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    This is a good view of different opinions in investing. I wanted to sell Tesla short at 250 because I figured the others would invade the electric car space and eat their lunch. Now I think their efforts in self driving will be the the thing that differentiates them from other brands. They have on the road data that will keep them ahead of the pack. No, I haven't bought it, either. – Ross Millikan Apr 7 at 2:04
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    Your point 1 is spot on as the others have pointed out. Your point #2 is less so: great thinkers often have awful ideas along with their brilliant ones. In particular the jury is still way out on self driving cars (I work for the DOT and we're already gearing up for them being a thing). – Jared Smith Apr 7 at 10:31
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    @Jared Smith: My point is not whether self-driving cars will be a "thing" or not, it's first that being a pioneer in the field exposes one to massive liability lawsuits when things go wrong, as news reports suggest they often do. Second, building self-driving into every car increases the cost, and ensures that people who don't want self-driving won't buy one. (FWIW, the self-driving is #3 on my list of reasons why I haven't bought a Tesla, despite the fact that I bought one of the first hybrid cars sold in the US.) – jamesqf Apr 7 at 17:29
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In addition to the other answers here (e.g. already overvalued, liabilities, survivorship bias in perception, ecosystem factors favoring competitor):

What would be reasons NOT to invest in a small company that has great leadership, talented workers and an amazing product?

One reason would be because the market doesn't value that product. There are plenty of amazing products that have been produced by small companies with great leadership and talented workers, but the part of the world with sufficient exposure to the company just wasn't ready for those amazing products until after the small company ran out of cash. Investors in those companies lost money. Product-market fit or lack thereof is a key determinant of a company's future success.

Low barriers to entry could also dissuade an investment. Suppose the startup had a great product-market fit in addition to all the other plusses you mentioned. What would stop a much more well-resourced giant competitor from making the same thing? With larger volume and an existing sales/distribution network, what's to stop a larger competitor from selling the same thing for just a bit lower price and drive the startup out of business? There are some good answers to this question (e.g. patents) but if the startup doesn't have a good answer, it may not be a great investment.

Alternatively, high barriers to entry that the company has not overcome could dissuade an investment, unless you have reason to believe those barriers are not too high for the company. For example, if the company's product clearly infringes on a competitor's patent and the competitor has refused or not been asked for a license, that would be a red flag for investment.

Another good reason would be if you can't afford to lose that money. Investing in startups is highly risky. You should plan on not having access to that money for years, probably forever. Would not having those funds prevent you from being able to put food on the table and a roof over your head? Would it stop you from being able to pursue other goals that you hold as a higher priority (e.g. returning to school or having a kid)? Would it prevent you from having the resilience to weather stormy economic conditions for several months, during which time you may not have income? If the answer to any of those or similar questions is yes, then no matter how amazing the product (or even product-market fit), how great the leadership, or how talented the workers, you should not invest.

A bad capitalization table can also be a major turn-off. Even if everything else about the company is fantastic, if the existing ownership structure is sufficiently messed up (e.g. giving all sorts of conversion to control rights to early investors who do not fall into the category of "great leadership") then getting involved is a disaster waiting to happen. When these situations occur (and they do!), if the new investment is large enough to make a material difference in the company's prospects and there aren't other suckers willing to substitute with a similar investment, sometimes existing investors might be willing to renegotiate their terms, especially if they think the alternative (e.g. no investment and bankruptcy) would be worse for them. A small individual investor is unlikely to carry enough weight to incentivize this.

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Everybody thinks they're investing in Apple, until it turns out they've invested in Enron.

We have the benefit of hindsight to be able to say that Apple, Amazon and Microsoft were all good investments today - back then, it wouldn't have been so obvious with their small company size and lack of foothold in the market.

That's not even mentioning that, for awhile, Apple would not have been considered a 'good investment' to be stuck with - given they were near bankruptcy at one point.

Tesla might be a good investment, if growth continues and the market holds stable for their products. Or it might collapse as cheaper electric cars become available and their major market share dwindles.

You won't know until it happens.

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    To be fair, investing in Enron wouldn't have been a problem. Failing to get our of an investment in Enron before it imploded would have a problem. Just like hindsight, we don't have foresight so it's impossible to know if even Apple, Amazon, Microsoft or Tesla are all just like pre-implosion Enron. – Justin Ohms Apr 6 at 21:44
  • @Justin Ohms: We do have foresight, just not a crystal ball. That is, if we look at a company, we might see that it's letting itself in for serious future problems, as with Tesla and self-driving car liability. While we can't know whether or not they'll successfully deal with that problem, the existence of potential problems should be factored into buying decisions. – jamesqf Apr 6 at 23:39
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    @JustinOhms Enron was foreseeable. It's financial statements were impenetrable, and didn't make sense, many stock analysts said so but were dismissed by momentum investors. Warren Buffett councils never investing outside of your circle of competence. If you don't understand their financials and how they make money, you'll be pretty easy to fleece. If you aren't comfortable reading financial statements you should be investing in index funds. – SafeFastExpressive Apr 8 at 16:23
  • I will say that there were signs Enron would collapse that people could've paid attention to - but at the same time, people still heavily invested in it thinking they were safe, and then only later discovered they were not. – Zibbobz Apr 8 at 17:27
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Just a small note here, I have heard an analyst say that the current value of Tesla makes it much higher than other auto makers who sell far more cars. Tesla's current market cap is valuing it on the basis that it is going to grab a very lot of market share away from the big auto makers. It could happen sure, but when it does, Tesla will be correctly priced already and unlikely that their price is much higher

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  • Good answer, expectations are already baked into a stock's price. Tesla is expected to gain a lot of market share in the future, which is why people think it's worth so much now. They'll have to do even better than what's expected to make the stock price go up. – Nuclear Wang Apr 8 at 19:49
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Some possible detractors:

Patent issues which cause an injunction,

Cloneability which causes another local/foreign company to make a more successful copy so that suppliers to change contracts after the factory is built,

Brand attraction,

Robustness,

Reality of cost/benefit and supply/demand,

Competition ecosystem: advent of a superior company/product/technology. A lot of people invested in Acorn computers, they were brilliant, but others were more pragmatic. Betamax was a brilliant home recorder, but VHS was even better.

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The reason "not to", is that success doesn't necessarily happen because a company has all those qualities.

Remember "crappy" companies make money too. Where "crappy" means they don't have all the features you describe.

The main questions are things like "Is there a market demand?" If the market demand is big enough, then it's easier to ship crap (make undue profit). Witness early days of Microsoft.

If you need an A+ execution for profit, you're more likely to fail. For example, only so many people get gold medals at the Olympics. Lots of people though, can run a marathon.

Now, you may like betting on someone who's going to grow potatoes on Mars. But the harder the goal, the more risk. Risk is what makes it hard.

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Why would you not invest in a small up-and-coming company, because half of businesses fail in the first three years. There is a reason startups try to give developers equity for compensation, it is virtually worthless?

It is also worth noting that the type of stock exchange the company is listed with has more to do with age than profit. In business terms tech companies come and go so quickly, they rarely last long enough to become fortune 500 companies.

Whether a company gets a main or secondary listing has more to do with how established it is. Tesla seems a bit young.

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  • This answer could be improved by addressing the specific scenario where the start-up "has great leadership, talented workers and an amazing product". The asker isn't thinking of investing in just any start-up. Although the other answers already address these other factors. – NotThatGuy Apr 7 at 11:16
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One more reason might be portfolio management. I would not put ALL my retirement money into one stock. The risk would be to high for a disastreous downturn.

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Since you mention Apple concretely, let me mention my relation with it. I do remember the numbers, not the exact dates. Around 20 years ago I bought a few (luckily) shares at $28 each. I held them for a while, I don't remember how long, but enough to receive ballots for some board elections; maybe a couple years. I sold those few shares at $10 each.

Someone who bought those shares at $10 in 2002, kept them for 18 years, and sold at the right time (mid February 2020), could have made a 3200% profit. I can assure you that was not obvious in 2002 (even if it was more or less predictable that the market would go up). And that profit would have been two months ago, but not today!

As it is repeated time and again on this site, "timing the market" is a recipe for failure: you'll never know in advance when it is the "right time" to buy or sell.

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  • Selling at the worst time in March 2020, the profit would have been "only" 2xxx% not 3200%. Still not bad. – Ben Voigt Apr 8 at 15:16
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One important consideration I didn't notice anyone mentioning with any company but especially smaller companies is cash. A company can have a positive top on their balance sheet but if they can't access cash in order to fund payroll or pay their suppliers, it can fail rapidly.

The general term here is a liquidity crisis. Usually a company can turn to debt to resolve short-term issues with cash-flow. Long-term cash-flow issues are generally fatal, however. There are other factors too. If there's a macro-economic credit crunch, for example, the company may not be able to cover their current liabilities through debt. Credit crunches are unfortunately a real risk these days and be rooted in events such as pandemics, terrorism, and bubbles.

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